Slow, But Steady

The U.S. economy is now midway through its fourth year of recovery.  Ignoring any occasional stock market euphoria, the economy remains on a constant path of slow improvement.  Real gross domestic product is on track to grow at a rate of around 2% this year, which is roughly the same growth rate observed in the previous three years of this recovery.

Although 2% GDP growth has been enough to allow occupancy levels to slowly improve in most property markets, it remains sub par to the growth rate required for widespread asset appreciation.  Beyond a few standout segments, such as trophy assets, landlords generally continue to fight fiercely for a thin line of tenant prospects.  Even at this maturing stage of the recovery, commercial real estate largely remains a market characterized by clear winners and clear losers.

Robert Schmitz
Robert A. Schmitz Corporate Real Estate Advisors

Element of Return on Investment

Within the last 30 years, there has been a shift in emphasis from valuation based on accounting income to valuation based on cash flow.  Many people now make statements like "cash flow is all that matters".  The reason for this emphasis on cash flows is that accounting earnings, per say, cannot buy anything.  Accounting earnings are mere constructs based on accruals of revenues and expenses, which have only a rough correlation with actual cash flows.  Cash flows, on the other hand, represent the actual dividends and distributions to the investor (which may be either positive or negative).  To the extent accounting earnings fail to reflect actual cash flows, they are not useful in assessing value and, consequently, return on investment.

Empirical studies support this view.  For example, some changes in accounting rules have had no effect on cash flows, but have caused material change in reported income.  In such cases (where the change in reported earnings had no correlation with the change in cash flows), research on publicly owned corporations shows that the stock prices are essentially unaffected.  This is evidence that investors do not rely on reported earnings when assessing the value of an asset.  It is the cash flow that contains the information necessary to assess value.

Robert Schmitz
Robert Schmitz Corporate Real Estate Advisors

Measuring Profitability

Investors have one overriding reason for measuring the profitability of an investment:  deciding whether to purchase or sell their investment.

Good guidelines for measuring profitability lead to the maximization of wealth, which means maximizing the value of all the assets an investor owns (real estate or otherwise).  Four of the most popular methods for measuring return are:

• Net Present Value
• Internal Rate of Return
• Return on Equity
• Payback

This analysis will produce some curious results:

• A project can have more than one internal rate of return.
• A manager who makes a 25% return on investment might be better than a manager who makes a 30% return on investment.
• A payback period of 8.5 years can be better than a payback period of 4 years.

Robert Schmitz
Robert Schmitz Corporate Real Estate Advisors